The continuing recovery of the manufacturing sector is set to return business output to growth, according to the latest Business Trends Report by accountants and business advisers BDO LLP.

BDO’s Output Index – which indicates how businesses expect their order books to develop over the next three months – has risen to 95.1 from 94.9 in June, returning above the point of contraction, 95.0. The small increase indicates that output is rising once again, albeit slowly.

Martin Gill, Partner and Head of BDO LLP in Scotland, said: “Amidst slowing growth in the economy as a whole, manufacturing is a definite bright spot at the moment.

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"However, our sense is that the recovery is weakening month on month. Given the continuing ability of the UK to create jobs at a surprisingly fast rate and the continuing relatively high levels of inflation, we can understand the calls for a hike in interest rates.

“But considering the economy's direction of travel we think that tightening monetary policy at this stage would be a mistake. Further, we think that there is a role for a somewhat more expansionary fiscal policy when Brexit uncertainty starts to bite further as we go into 2018. The Chancellor cannot increase current spending without increasing taxes. But we think that the markets would be happy to see him borrow more for investment in our productivity and growth potential.”

The report reveals that the return to output growth has been driven solely by the improving performance of manufacturing as the services output continues to contract. BDO’s Manufacturing Output Index increased to 98.6 in July from 97.6 in June, and is rising closer to the long-term growth trend at 100.

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The rsecovery of the manufacturing sector is encouraging for the health of the economy. However, as the sector only now accounts for a about a tenth of all UK economic output, its resurgence has a marginal effect on the overall growth of the economy, reflected by the 0.2 rise in the overall Output Index.

BDO’s Services Output Index remained at 94.4 for the second month running, 0.6 below the point of contraction of 95.0. According to ONS figures, the services sector grew 0.5% in Q2 of 2017, but the Services Output Index indicates that order books in the sector are set to shrink in the coming three months, which would leave the growth of the UK economy stuttering towards the end of 2017.

BDO’s Optimism Index suggests a more positive outlook for early 2018, particularly for manufacturers. The Optimism Index – which indicates how firms expect their order books to develop in the coming six months – increased to 103.0 in July, from 102.9 in June. Echoing this month’s Output Index, the manufacturing sector is responsible for the increase.

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The results show that manufacturers in Scotland and the wider UK are expecting a flurry of business activity, with its sector Optimism Index climbing to 121.4, well above the long-term trend. However, the services sector outlook for 2018 is less optimistic. Its sector Optimism Index has fallen 0.1 to 99.5 in July, below the long term trend but still in growth territory. The overall outlook from services has been on a downward trend since 2015, but this has been more distinct since the EU referendum.